Election in Japan: Will a New Government Revive Growth?

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Following three-and-a-half years of government marked by scandal, incompetence and hesitation in the face of a natural disaster, voters in Sunday's election in Japan voted in a new party.

Japanese voters turned their backs on the Democratic Party of Japan (DPJ) and returned the Liberal Democratic Party (LDP) to power in a landslide victory.

The LDP, which ruled Japan continuously for more than 50 years, has been chastened by its time in opposition and returns to power with a renewed vigor and strengthened belief in its core values.

Sunday's election, which had been characterized as a referendum on the future of nuclear power in Japan, actually turned out to be a vote in favor of competence and experience in governing.

Voters handed the LDP/Komei coalition a veto-proof majority of 325 seats in the Lower House of the Diet.

Under Japan's parliamentary system, if a bill passed by the Lower House is rejected by the Upper House, it can be resubmitted to the Lower House and become law if approved by a two-thirds majority. That means even the most radical LDP policies can become law over the objections of the opposition.

That's a good thing because LDP president Shinzo Abe, who will be the next prime minister, has some pretty radical ideas for dealing with Japan's economic malaise.

The New Key Economic Policies Post-Election in Japan

First, Abe plans to pass a massive 10 trillion yen ($120 billion) supplementary budget which will be spent during the January-March quarter. This money will be spent on public works and other construction projects.

In the aftermath of last year's devastating earthquake and nuclear accident (more on that later) there are plenty of things to spend money on: rebuilding the Tohoku area, retrofitting public buildings, such as schools and hospitals, to make them more earthquake resistant, repairing highways, bridges and tunnels; there is plenty to do before building another bridge to nowhere.

These projects will be funded primarily by issuing new Japanese government bonds (JGBs). Given that Japan already has a debt-to-GDP ratio of 237%, a massive new JGB issue could threaten the country's credit rating and possibly weaken the yen.

But Abe doesn't care.

"This supplementary budget is for the purpose of eliminating deflation so it has to be big," Abe told a press conference in Tokyo this morning.

Second, Abe wants the Bank of Japan (BoJ) to create "unlimited easing" in its monetary policy and calls for close coordination between the central bank and the government. Abe has said that he wants the BoJ to adhere to an inflation target of 2% and has been highly critical of BoJ Governor Masaaki Shirakawa's timid approach to Japan's persistent deflation.

To that end, Abe said he will revive the Council on Economic and Fiscal Policy. This was established in January 2001 as part of the Cabinet Office and, although the law creating the Council remains in place, the Council has been unstaffed and dormant since 2004.

Abe wants to revive the Council, "…which will be the control tower for macroeconomic policy. The Bank of Japan governor must be a member of the Council," Abe commented at today's press conference. "Through the election, the voters have asked the Bank of Japan to come to a policy agreement [with the government]. I accept the election result and I hope we can come to an appropriate conclusion."

Clearly, Abe will use the Council on Economic and Fiscal Policy as a stick to beat the BoJ.

BoJ Governor Shirakawa's term ends at the end of March 2013 and he is likely to be replaced with someone more attuned to Abe's way of thinking. While Abe does not appoint the BoJ governor in the same way that the President appoints the chairman of the Fed, Abe will certainly influence the decision.

Critics say this will compromise the Bank of Japan's independence, which was only established by law in 1999. Theoretically, a central bank that is at the beck and call of politicians could undermine faith in Japan's currency.

But Abe is unfazed. He has called for a revision of the Bank of Japan Act to make the BoJ more accountable to the government and to enforce adherence to an inflation target. After yesterday's election result, Abe will have the votes to do whatever he pleases to the central bank.

End of the Pacifist Constitution?

Perhaps the most radical of Abe's policies is revision of Article 9 of the Japanese Constitution which states, in part, "…the Japanese people forever renounce war as a sovereign right of the nation and the threat or use of force as means of settling international disputes."

To that end, Abe plans to first amend Article 96 of the Constitution to make it easier to pass new constitutional amendments. Here, Abe has the support of some of the conservative opposition parties so this is something that could be achieved relatively quickly.

An end to Japan's constitutional pacifism would open the door to increased military spending-Japan already spends about 1% of GDP on its military and has the world's sixth largest military budget. The Constitution has been interpreted as prohibiting military exports but that could change too.

What's Next for Japan's Economy?

Money Morning Chief Investment Strategist Keith Fitz-Gerald appeared on FOX Business Network with Stuart Varney this morning to discuss the election in Japan.

Fitz-Gerald was asked if Abe's plan to print more money and to increase spending on public works and the military would end Japan's persistent deflationary spiral.

"Unfortunately no," Fitz-Gerald replied. "They have got a demographic problem … They are dependent upon exports. Those are falling. The economy is contracting. They have increasingly fewer workers supporting a huge generation of retirees. This is a non-reversible window of opportunity."

"People are going to have to change what makes them Japanese in order to survive this," Fitz-Gerald continued.

Abe seems willing to take some big risks in his economic policies and to tackle some of Japan's core beliefs about itself by making the revision of the Constitution a key element of his platform.

But Fitz-Gerald is right. None of Abe's policies address the underlying demographic issue of Japan's shrinking population.

To watch Fitz-Gerald's appearance on FOX Business about the election in Japan, click here.

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